Financial Investment Opportunities and the Macroeconomy



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    • Graduate School of Management, University of California, Irvine and Hong Kong University of Science and Technology. I am grateful to George Constantinides, Eugene Fama, Wayne Ferson, Dave Mayers, Merton Miller, Dan Nelson, Richard Roll, Stephen Ross, Neal Stoughton, Ren Stulz, Victor Zarnowitz, and the workshop participants at Chicago, Irvine, Minnesota, National Taiwan University, Tamkang University, Academia Sinica in Taipei, Stockholm School of Economics, Swedish School of Economics in Helsinki, the European Finance Association Meetings in Stockholm, and the EIASM conference on the random walk of stock prices in Brussels for helpful comments and suggestions. This paper was delivered at Tamsui as a Tamkang University Chair Lecture. I also thank Roger Ibbotson for providing some of the data, Raymond Kan for computational assistance, and the Center for Research in Security Prices for support.


This paper studies the relation between changes in financial investment opportunities and changes in the macroeconomy. States variables such as the lagged production growth rate, the default premium, the term premium, the short-term interest rate and the market dividend-price ratio are shown to be indicators of recent and future economic growth. Further, the market excess return is negatively correlated with recent economic growth and positively correlated with expected future economic growth. These results offer straightforward interpretations of recent evidence on the forecasts of the market excess return by state variable via their forecasts on the macroeconomy.